The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Dassault Aviation SA (EPA:AM) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Dassault Aviation's Net Debt?
As you can see below, at the end of June 2019, Dassault Aviation had €970.6m of debt, up from €1.1k a year ago. Click the image for more detail. But it also has €5.72b in cash to offset that, meaning it has €4.75b net cash.
A Look At Dassault Aviation's Liabilities
According to the last reported balance sheet, Dassault Aviation had liabilities of €12.3b due within 12 months, and liabilities of €226.5m due beyond 12 months. Offsetting this, it had €5.72b in cash and €1.17b in receivables that were due within 12 months. So its liabilities total €5.60b more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Dassault Aviation has a huge market capitalization of €9.56b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Dassault Aviation boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Dassault Aviation grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dassault Aviation's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Dassault Aviation may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Dassault Aviation actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Although Dassault Aviation's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of €4.75b. The cherry on top was that in converted 241% of that EBIT to free cash flow, bringing in -€21.4m. So we don't think Dassault Aviation's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Dassault Aviation you should know about.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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